What’s the best way to give money to my adult children?

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Q. I want to give money to my adult children each year, maybe about $20,000 each. Should I give them mutual funds I already own, or give cash, or some other way? I want them to save the money for retirement.
— Feeling generous

A. The new year and the holiday season is a common time of year that families choose to gift cash or securities.

We’re glad you’re proceeding with caution so you can come up with a strategy to maximize the benefits of gifting and minimize any potential tax implications.

First, you need to pay attention to the annual gift tax exclusion when deciding upon the amount to give, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

“The gift tax can be exceedingly high, with current federal rates of as much as 40%,” he said. “Every year, you can give up to a certain amount to anyone you want without having to deal with the gift tax at all. For 2020, that amount is $15,000.”

For example, DeFelice said, if you have three children and you want to max out your giving, then you could give a total of $45,000 without any gift tax consequences or having to file a gift tax return. Additionally, the annual exclusion is per person, which means that if you’re married, you and your spouse could give away a combined $30,000 a year to each child — or whoever you choose — without having to file a gift tax return, he said.

“If you gift somebody more than the annual exclusion amount, you’ll end up having to file a gift tax return with the IRS,” DeFelice said. “However, that still doesn’t mean that you’ll have to pay any tax.”

That’s because on top of the annual exclusion amount, there’s also a lifetime exemption from gift and estate tax that you’re allowed to use. For 2020, that amount is $11.58 million — far greater than most people will ever give away in their lifetime.

Unlike the annual exclusion amount, the lifetime exemption applies to all the gifts you make, rather than on a per person basis, DeFelice said.

Now let’s look at your example.

If you give $20,000 in gifts to each child in 2020, you’d have a taxable gift of $5,000 each, and that would use up a small piece of your $11.58 million exemption. However, you’d still have plenty left for future gifts during your lifetime or for money that you transferred to your heirs after your death, DeFelice said.

“The only time you pay any gift tax out of pocket is if you use up your entire lifetime exemption, which is rare for most Americans,” he said. “We always recommend high net worth individuals consult with a tax and financial advisor before gifting any assets to develop an appropriate long-term strategy.”

As far as gifting cash or stock, there are several variables to consider.

DeFelice said gifting securities like stocks or mutual funds to family members can be tricky, and there are several ways you can get tripped up and inadvertently make a poor decision from a tax standpoint.

If the gift occurs during your lifetime, the person receiving the gift will assume your cost basis, he said. However, if mutual funds are inherited by your children after you pass away, they will receive a step-up in cost basis to the date of your death, meaning they can sell it for no capital gains tax. This could mean a big difference in how much investment growth they get to keep, he said.

And there are other factors to consider.

“For instance, if the funds you want to give have appreciated in value, you may have unrealized losses elsewhere in your portfolio that could cancel out your unrealized capital gains if you sold them and gifted the cash instead,” he said. “Further, since a mutual fund sale counts toward overall taxable income, a gift recipient may inadvertently get nudged into a higher capital gains tax bracket when they sell it — creating a higher tax consequence than intended.”

As for you wanting your kids to use the money for retirement, that’s a great sentiment. Unless you put funds in a trust, you won’t be able to force them. We suggest you sit down and have a conversation about your wishes for the money, and hope that your children will follow them.

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This story was originally published on Jan. 8, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.